What is a pre-payment penalty?

Prepayment charges can all get calculated using different methods. Each financial institution may have their own way of calculating the cost of leaving.  In a fixed rate mortgage, the cost will be the greater of 3 months interest OR interest for the remainder of the term calculated on the amount you prepay. This gets calculated using the IRD (Interest Rate Differential). 

On a variable rate mortgage, it is 3 months interest.

Scenario 1

Here's an example of a three-month interest pre-payment penalty on a variable rate mortgage.

$200,000 mortgage balance @ 5%
20 months remaining in the term 
Monthly payment: $833.33
3 month interest prepayment penalty $2,500

Scenario 2

Here's an example of the Interest Rate Differential calculated on a fixed rate mortgage.

$200,000 mortgage balance @ 5%
Interest Rate Differential is 1% (The current interest rates at the time of prepayment is 4%).
Monthly IRD amount is $166.66. 
$166.66 x 20 months remaining = $3,333.33.

As you may have noticed, a fixed rate mortgage can be more costly to exit. Each lender can calculate their IRD in different ways. Major banks base their IRD on the Bank of Canada's posted rates. This could mean even higher penalties.

Although major banks have their place in the mortgage market, they can be the most costly option. I can help guide you to pick the lender with the most favourable pre-payment penalty option so you can be confident that if you had to exit, you wouldn't pay a substantial penalty.

If refinancing, most people choose to incorporate their mortgage penalty into their new mortgage. 

I can help you determine your prepayment penalty. Give my office a call today and I'll walk you through it, free of charge.

Contact me today.